NEW YORK  Borrowing money to buy anything — a 4,000-square-foot center hall colonial, a 390-horsepower Maserati, a trip Down Under — is inherently risky, because the purchase is typically made with cash that people don't have.

Taking out a loan to purchase stocks, a Wall Street practice known as buying on margin, is also a risky proposition. The stock market crash of 1929, for example, was caused partly by investors being forced to liquidate stocks — most of which were in free fall — to pay back margin loans used to fund part of the initial investments.

Despite the potential downside, there appears to be a growing number of investors — apparently emboldened by stocks hitting record highs — willing to take that risk.

Buyers, keep this in mind

The NASD, a brokerage regulator, recently sent out an "alert" to investors outlining the risks associated with margin. Through the end of March, the latest data available, the amount of debt taken on by investors to buy stocks totaled $317.7 billion. And while that was a bit below the $321.2 billion record hit in February, it still surpasses the $300 billion in March 2000 at the top of the tech-stock bubble.

A sharp rise in margin debt means investors are eager to own stocks. And such spikes are often associated with market tops, as was the case in 1929 and 2000.

Sure, investors have a chance to boost returns by using other people's money — a technique called leverage — to buy more shares than they could on their own. But buying on margin is just another form of debt, another IOU, another buy-now-pay-later transaction.

"We're not trying to set off alarm bells," says Elisse Walter, senior executive vice president at NASD. "But with margin debt (near record levels), we felt it was a good time to remind retail investors what margin is, how it operates and what the risks are."

The strategy isn't for the meek. If the value of an investor's holdings heads south in a hurry, they could end up with a triple whammy. They run the risk of having to quickly pay back part — or all — of the loan to meet a "margin call"; pay interest on the loan; and absorb the loss caused by the decline in the value of the holdings.

Investors can lose both borrowed money and their own money in a margin account.

How it works

Here's a simple example of how buying on margin works: You want to purchase $10,000 worth of Google shares. In general, under Federal Reserve rules, you can borrow up to 50% of the total purchase price. You fork over $5,000 of your own cash and borrow $5,000 from your broker.

Why do it? If stocks rise, borrowing can boost returns. Assume Google shares rise 20%, boosting the value of your $10,000 investment to $12,000. Since you used borrowed money to finance half of your purchase, your percentage return is actually 40%, since the $2,000 gain was garnered using only $5,000 of your own money.

"You are basically doubling up," explains Price Headley, chief at BigTrends.com. "You are basically getting two times the buying power" and double the return.

But leverage cuts both ways, and can amplify losses as well as gains. Declining markets are deadly for margin investors, Johnson adds.

And on the downside …

Say that initial $10,000 investment in Google falls 20% to $8,000. Your net loss doubles to 40%, since your initial cash investment of $5,000 has been reduced to $3,000

Investors may also be subject to the dreaded margin call.

The reason: If the price of the stock you bought with borrowed money loses value and your margin account balance drops below a certain level, it could prompt a margin call from your broker.

The stocks in your brokerage account are collateral for the loan, so your broker will contact you and ask you to deposit more money into your account to meet minimum balance requirements. If you can't come up with the cash, the broker has the right to sell stocks or other securities in your account without your knowledge or consent.

To avoid a margin call, Wells Fargo recommends that investors monitor their account carefully and provide a buffer for themselves by not using all the available funds in their margin accounts.

NASD's Walter adds one final piece of advice: "Never go into an investment you don't understand. You have to understand both the upside and downside."

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